Investment Risk Management

Investment Risk Management

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Investment Risk Management

Introduction

Market calamities are not new events for present day corporate organizations. The millennium brought about novel fiscal crisis aspects that in turn led to an emphasis on issues revolving around public policy, maintenance of monetary stability, protection of consumers and regulation of corporate institutions. On 15 September 2008, financial markets globally were in a panic because of the economic meltdowns. Many large corporations such as the Lehman Brothers fell during the crisis. However, the institution could have been saved through government or private buyer aid. Such occurrences result in increased scrutiny concerning federal and executive roles in investment protection and risk management. Corporate governance is a generic concept that necessitates implementation of effective regulatory policies that across all organizational structures in accordance with operational sizes and scopes.

Factors behind Lehman Brother’s Bankruptcy

The bankruptcy of the Lehman Brother’s was greater in complexity and scope when compared to that of Enron. Encompassing $600 billion in assets, the leading investment bank plunged in the global fiscal crisis because of the following reasons.

Lack of Buyers

The unavailability of a buyer was the single primary problem as a number of stable institutions were constrained in acquiring the firm. The acquisition was perceived as the acceptable alternative to failure. However, stable firms such as Barclays were limited in finalizing the process because of incompatible British regulations. This is seen in the Treasury Secretary Hank Paulson’s statement, “The British Screwed Us” (Indiviglio, 2010).

A Poor Balance Sheet

Given that there was no available buyer, the subsequent alternative was seeking aid from the Federal Reserve in the form of an emergency loan. However, the national fiscal body opted not to support because it felt the company’s balance sheet had a weak collateral structure to back up the aid (Indiviglio, 2010). Government aid could have saved the firm, but technical bureaucracies could not allow it to intervene.

Lehman Brothers had no Hold on the Average American

The perception of private and public economists was that unlike AIG, the failure of Lehman Brothers would indirectly affect Americans. Because of the political system present at the time, losses in the organization would only directly affect institutional investors and investment bankers who had stocks in the firm (Indiviglio, 2010). There would be no fall out at Wall Street or in insurance agencies, meaning the company’s collapse was negligible.

Effectiveness of Present Day Risk Management Techniques

The global financial crisis brought about new challenges that equally necessitated complex responses. To assess the effectiveness of applied risk management techniques, we look at the four classes of risk management practices.

Risk Identification and Measurement

The Subprime Mortgage crisis happened because of risk underestimation. This, in turn, suggests referencing of misleading measurements. Economists argue that there is an insufficient appreciation of risk measures inclusive of both qualitative and quantitative measures. Modern stress testing improves quantitative measures in risk management (Bernanke, 2008). However, the rate of risk dynamicity still supersedes identification and measurement techniques.

Valuation

According to Bernanke (2008), best practices in valuation demand an organization to be internally capable of performing accurate in-house evaluations. In addition, the same companies must incorporate external expert auditors to perform the same corporate evaluations. Less successful firms during the Subprime Mortgage crisis depicted the inability to perform in-house audits, thus were reliant on external evaluations (Bernanke, 2008).

Liquidity Risk Management

History teaches that corporate liquidity is subject to influence from market liquidity. Therefore, organizations require enterprise-wide liquidity controls that safeguard against market erosions. Presently, companies ascertain inclusion of contingency funds and maintenance of strong and accurate off-balance-sheets (Bernanke, 2008). In this, companies do not have funding pressures.

Senior Management Oversight

Corporate performances are differentiated by the strength of the senior management oversight. Present senior managers determine the company’s general risk preferences, design controls and incentives that motivate employees to conform to the generic preferences (Bernanke, 2008). The argument and emphasis are on corporate culture and governance in the establishment of quality risk management.

Management’s Role in Establishing Risk Management Procedures

Management has a separate role to that of the board of directors because they are more engaged in the physical working environment. Management is an active participant that has the mandate of implementing the risk management procedures designed by risk managers, executives and the board of directors. Dependent on the nature of circumstance, managers may also be involved in the design of risk management processes and subsequent implementation (McIntosh, Lipton & Katz, 2010). Another role for managers in risk management is finding a balance between executive and employee requirements. Managers have to ascertain that executives and employees agree and are engaged in actuation of key areas. In this, managers act as support staff between the two sides offering advice where necessary.

However, the main mandate for managers in risk management is the development and implementation of suitable corporate culture and governance structures (McIntosh, Lipton & Katz, 2010). Such structures aim at long-term growth of stakeholder value, employee satisfaction, and corporate profitability based on innovation and reasonable risk-taking. Managers supervise employee functions while ascertaining that they conform and align to the bigger executive strategy and objectives. Through managerial leadership, messages on best practices and organizational requirements are conveyed and received better and broadly. If there is a breach of fiduciary duty, the respective board or board member is personally held liable for the fiscal damages in terms of pecuniary losses (Wachtell, Lipton & Katz, 2010). The court has to assess the punitive damages by exacting moral obligations against the responsible board members (McIntosh, Lipton & Katz, 2010).

Impact of the Eurozone Debt Crisis on the Foreign Market

The Eurozone is a vital market for major world economies inclusive of Japan, China, America, United Kingdom, Germany, Russia, and India amongst many others. Given its imperial importance, the debt crisis in the market was met with novel legislations that though strict strengthen economic stability, governance, and coordination (Chance & James, 2012). For one, governments can no longer borrow unsustainable debt levels and must keep balanced budgets at all time. Any government that attempts to ignore the above guidelines is met by global financial sanctions (Chance & James, 2012). When it comes to financial aid from regulatory bodies, the Eurozone crisis means less available funds as most aid is availed to the recovery of the Euro. In meaning, there is so much pressure to revive the Euro that funding bodies such as the International Monetary Fund (IMF) experience economic difficulty in the imbalanced aid schemes (Chance & James, 2012). At a lower level, the Eurozone crisis meant fewer opportunities for foreign trade for Europeans.

However, learning from the 2008 global crisis, recovery strategies as already put in place include federal aid, review of old legislation and implementation of new ones. There is also scrutiny of the Treaty on the European Union to allow a process of negotiation for countries contemplating to exit the financial system (Chance & James, 2012). For countries still within the system, there is documentation of bond markets to improve warning flagging of risks. There is also the argument on fallback currencies at the local level in case the Eurozone collapses (Chance & James, 2012). The piggyback currencies will allow member states to revive local economies.

Role of the Federal Government in Corporate Investment Regulations

Policy Making

The prime mandate for the federal government is the derivation of investment regulations in accordance to the respective economic and market scopes (Campbell, 2009). Therefore, the government has the responsibility for assessing the internal and foreign markets to gain knowledge and understanding that is later applied in policy derivation. Sound macroeconomic policies improve the credibility of the regime and solidify political institutions resulting in increased trade interactions and opportunities (Campbell, 2009).

Policy Enforcement

Policy enforcement has immediate consequences at both corporate and individual levels, especially for violators. In enforcement, federal auditors ascertain that organizations record and report accurate fiscal data on quarterly basis and in conformance with accepted global financial accounting standards (Campbell, 2009). The government imposes criminal sanctions on individuals and organizations that malpractice, resulting in long-term losses in pensions, public trust, and subsequent business opportunities. In adverse cases, violators face incarceration.

Restore and Maintain Economic Stability

The federal government must provide a suitable stable environment that encourages economic growth. Such an environment depends on the defense of property rights, protection of private partner transactions and currency stability (Campbell, 2009). If the economic factors are managed well, market participants invest their resources increasing entrepreneurial opportunities and overall profit margins.

 

 

 

References

Bernanke, Ben. (2008). Risk Management in Financial Institutions. Board of Governors of the Federal Reserve System. Retrieved from http://www.federalreserve.gov/newsevents/speech/bernanke20080515a.htm

Campbell, Karen. (2009). The Economic Role of the Government: Focus on Stability, Not Spending. Heritage Research. Retrieved From http://www.heritage.org/research/reports/2009/09/the-economic-role-of-government-focus-on-stability-not-spending

Chance, Clifford & James, Simon. (2012).The Eurozone Crisis and Its Impact on the International Financial Markets. HLS Forum on Corporate Governance and Financial Regulation. 31 (3). 45-69.

Indiviglio, Daniel. (2010). Four Reasons Why Lehman Brothers Failed. The Atlantic. Retrieved from http://www.theatlantic.com/business/archive/2010/09/4-reasons-why-lehman-failed/62588/

Katz, D., Lipton, W., & McIntosh, Laura. (2009). Boards Play A Leading Role in Risk Management Oversight. New York Law Journal. 29 (2). 21-31.

 

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